After a significant price rise the last few years from $28 to $72 per share, an outside observer might think Newmont (NEM) is ready to reverse to the downside. If you guessed the stock is overvalued and dead money in coming years, you would be wrong. Based on historical valuation models and flat gold, silver, copper prices, Newmont’s underlying worth today is $100-120 a share, not the current $63 quote! And, if precious metal quotes climb during 2021, the stock quote could easily surpass the high end of this range in 12-18 months. How many other industry leading, high profit margin, blue-chip businesses can be purchased at a 50% discount to underlying statistical data points when the U.S. equity market is trading at all-time record pricing? Not many, if any.
Image Source: Company Presentation
As many regular Seeking Alpha readers are aware, I am something of a gold bug, trading precious metal investments since the 1980s. I have written numerous articles over the years explaining the long-term ownership positives of Newmont. Perhaps the single miner with the best combination of world-class reserves (in the 20 to 30-year range depending on metals pricing), diversification of mines globally in mostly safer sovereign jurisdictions for private mining asset interests, sound financials with little debt, plus industry-high profit margins and free cash flow, Newmont should be a considered a “core” gold/silver holding in your portfolio.
Why do I think Newmont is still primed to rise in price markedly into 2021-22? Namely, free cash flow and earnings yields are too low vs. today’s economic environment. Rising metals prices and ultra-low interest rates for savings, including the “risk-free” Treasury yield curve, are both pushing up the value of long-lived gold/silver/copper mining assets. Over decades of trading history, top-tier miners like Newmont have witnessed stock pricing as a function of annual cash generation at yields UNDER the prevailing Treasury bill and note rates as alternatives. With Treasury rates, less than 10 years in duration, well below 1% presently, Newmont’s free cash flow yield of 4% on a trailing basis, and an estimated 6% for 2021 is laughably low (assuming flat metals quotes). Using this analysis as your only data point, prices of $150-200 per share for Newmont right now do not look unreasonable. Below is a chart of trailing free cash flow yields from the large cap peers and competitors in the global gold/silver mining space, of which Newmont is a leader.
However, the marketplace and my own modeling suggest interest rates cannot stay this low forever. Newmont’s price seems to be discounting a bleaker gold/silver price future, and/or a sharp jump in interest rates during 2021-22. Otherwise, Barrick (GOLD), Kinross (KGC), Kirkland Lake (KL), Agnico Eagle (AEM), Anglogold (AU), Gold Fields (GFI) and Pan American Silver (PAAS) would be trading at dramatically higher quotes today.
A second, and equally important, relative comparison that has worked over many decades is to review earnings and free cash flow yields available from blue-chip precious metals miners, and contrast it to the equivalent S&P 500 setup. Under this analysis, Newmont still looks comparatively cheap (as do gold/silver peers), even if metals pricing does not zig-zag higher next year. The company’s trailing operating P/E ratio around 25x is too low, especially if earnings hit upgraded Wall Street estimates during 2021-22. Considering the S&P 500 is priced between 30-35x trailing income results during the COVID-19 recession, and Newmont typically sells at some sort of premium ratio (because gold/silver are still considered more valuable than paper money assets like Treasuries, regular bonds and equities), a 20-30% discount right now may be completely mispriced.
If we put just a “market” multiple of 25x on next year’s earnings (the same P/E as estimated by Wall Street firms for the S&P 500 index in 2021), Newmont’s $4.00+ in projected earnings per share by early 2022, gives us a price of $100 a share. Again, if interest rates remain low and gold/silver/copper continue their uptrends, this forecasted underlying value number remains on the low side.
Studying a variety of financial metrics, Newmont holds the enviable position of being one the most profitable and conservatively-run gold/silver miners. Below I am drawing a variety of data points to research vs. the large capitalization mining industry. The 1.24% dividend yield remains at an industry-leading level, above the Treasury bill marketplace of sub-0.5%, and roughly comparable to the S&P 500 cash distribution rate of 1.7% today.
Income generation per employee is far above average, with only Kirkland scoring higher last year.
While the majority of miners are just becoming free cash flow positive in 2020, Newmont is a leader in free cash flow to debt comparisons. Trailing return on assets and profit margins are also top tier for the gold and silver mining industry.
Yet, despite super-bullish margins/returns and an exceptionally bright operating earnings future, valuations are inexplicably holding in the middle of the range of peer gold/silver mining companies. On trailing price to sales and accounting cash flow, Newmont is not valued at the top of the class. Usually on Wall Street, industry-leading assets and margins equate with premium valuations vs. the sector.
Again, on forward price to earnings and income growth estimates, Newmont is nowhere near the expensive side of the valuation ledger. It has the best track record of reaching Wall Street estimates the last decade, and the strongest asset backing, but only an average valuation??? For my money, the stock sounds like an outrageous bargain, assuming gold/silver/copper prices do not fall appreciably the next 12-18 months.
Technical Momentum Remains Strong
Investor trading activity and related momentum indicators have been quite bullish for all of 2020 in both the metals marketplace and Newmont specifically. Below I have drawn 2-year price and volume charts of daily trading for Newmont, spot gold futures, silver futures and copper futures. [The Newmont 2020 operating sales breakdown into June Q2 was 90% gold, 5% silver, 5% base metals including copper.] Notice the healthy and steadily improving trends in some of my favorite technical indicators, the Accumulation/Distribution Line, Negative Volume Index and On Balance Volume. You can also review how the sharp September metal sell-off has done little to dent the longer-term upmove in this important money printing and inflation hedge space for investors.
Modeling a Newmont price target above $120 next year is anything but crazy, if metals pricing rises again in 2021. Given today’s $63 stock price, record money printing levels by central banks the world over, an uncertain economic future caused by the pandemic recession, and the lowest U.S. interest rate backdrop since the 1930s Great Depression, investors should seriously weigh the pros and cons of an investment in Newmont. Risk-reward analysis points to a still inexpensive entry price for Newmont, if you are expecting a flat to higher precious metals market next year. Assuming gold is headed to $5,000 an ounce, and silver $100 in 3-5 years, Newmont’s upside “potential” is well above the typical U.S. blue-chip equity. Don’t laugh, but like I have mentioned in past articles, Newmont may trade above $200 a share several years down the road.
I own shares in my diversified long/short portfolio, both as a hedge against wild swings on Wall Street and a speculation that record money printing rates (dollar devaluations) will remain in place during 2021-22. Can certain scenarios create a $45-50 stock quote first? Sure, a general stock market crash, an excessively expensive takeover bid of another miner (not many are left), or a sudden collapse in precious metals quotes would send Newmont’s stock price lower. The good news is all of these events would likely prove more of a passing problem, that would limit gains over the short run, without damaging the long-term appreciation potential of the shares. We saw a similar temporary setback in March, as the pandemic mass-liquidation panic hit all equities, even gold/silver miners.
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Disclosure: I am/we are long NEM, PAAS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This writing is for informational purposes only. All opinions expressed herein are not investment recommendations, and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity and is not a registered investment advisor. The author recommends investors consult a qualified investment advisor before making any trade. This article is not an investment research report, but an opinion written at a point in time. The author’s opinions expressed herein address only a small cross-section of data related to an investment in securities mentioned. Any analysis presented is based on incomplete information, and is limited in scope and accuracy. The information and data in this article are obtained from sources believed to be reliable, but their accuracy and completeness are not guaranteed. Any and all opinions, estimates, and conclusions are based on the author’s best judgment at the time of publication, and are subject to change without notice. Past performance is no guarantee of future returns.
Originally published on Seeking Alpha